Cooking the Books: Banking Demystified Again

If we keep banging on in this column about banks only being able to lend money they have, it’s because the opposite view – that they can make loans out of thin air – is so widespread amongst critics of capitalism.

Here are two examples taken from leaflets posted on a wall near the Occupy camp at St. Paul’s. One called for “an end to creating money out of thin air on computer screens and charging interest on it.” The other claimed that “Money” is created as borrower debt to banks. Most of today’s so-called ‘money’ is actually bank credit, just numbers in a bank account. “These numbers are created simply by borrowers promising to pay these numbers back to the bank!”

And here are two counter-examples. Last year The Times (21 November) reported on the situation in the Inner Mongolian city of Ordos in China:

“Money made from the region's huge coal reserves or land compensation has made many residents rich, people who, instinctively, have looked for ways to invest that money as real interest rates from bank savings have slipped into negative territory. By way of loan sharks and other methods of underground financing, that money has been churned back into property investment and more building.”

What you had there was people with money to lend and others who wanted to borrow money. Because the official banking system was unable to satisfy this, an ‘underground lending market’ developed. Even if those who acted as intermediaries between the lenders and the borrowers were shady individuals and gangs, they were acting as banks everywhere do: borrowing money at one rate of interest and lending it at a higher rate, making a profit out of the difference after their expenses had been settled.

If banking could create loans out of thin air you can be sure that the underground bankers of Ordos would have done this as, with no interest to pay the people lending them the money to re-lend, it would have been much more profitable. The only reason they didn’t was because they couldn’t. Nobody, whether above board or shady, acting as a bank can conjure up money to lend from nowhere. They have to have the money before they can make a loan.

The second example is that of the high-class pawnbroker Borro which last year proclaimed in an advertisement in the London Evening Standard (13 December):

“Borro provides short-term loans from £1,000 to £1 million against valuables, including Jewellery, Luxury Watches, Fine Art & Antiques, Gold and Prestige Cars. Their service is discreet and flexible with no credit checks. Money can be provided within 24 hours.”

One of the claims of those who say that ‘money is debt’ is that money is created by a bank as a counterpart to the IOU signed by the borrower by simply keying in some numbers into a computer. But if banks can create money to lend simply on the basis of an IOU signed by the borrower, why can’t pawnbrokers? But they can’t. They must have the money first. The Times (28 December) revealed the source of the money Borro lends: “Loan funding has come from Kreos Capital, which also backs Wonga, the payday loans company whose high interest rates provoked controversy recently.”

Banks are no different in this respect. They, too, have to get “loan funding”, whether from those who deposit their savings with them or from what they themselves have borrowed on the money market or from their own resources.